Working Paper: CEPR ID: DP8810
Authors: Gianluca Benigno; Hande Kk
Abstract: We show that recent explanations of the consumption-real exchange rate anomaly which rely on goods and financial market frictions are not robust to introducing just one additional international asset. When portfolios are selected optimally, international trade in two nominal bonds implies a consumption-real exchange rate correlation that is too high compared to the data even when there are many shocks. Monetary policy specification plays a potentially important role for the degree of risk sharing provided by nominal bonds, both in the benchmark model with only tradable and non-tradable sector supply shocks and also in the model which allows for news or quality (i-pod) shocks.
Keywords: Consumption-Real Exchange Rate Anomaly; Incomplete Financial Markets; International Risk Sharing; Portfolio Choice
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| introduction of a second internationally traded bond (G15) | correlation between relative consumption and real exchange rates (F31) |
| specification of monetary policy (E52) | degree of risk sharing provided by nominal bonds (G12) |
| tradable and nontradable sector shocks (F16) | relationship between relative consumption and real exchange rates (F31) |